Adjust withholding on W-4 to keep tax credit on track

Your next paycheck will probably be a little fatter than usual, but it's not because your boss thinks you're swell. Instead, the increase reflects the Making Work Pay credit, part of the economic stimulus package enacted this year.

Most taxpayers will receive a credit of about $400, or $800 for married couples. Unlike last year, you won't receive a check in the mail. Instead, the credit will be spread out over the year. Most taxpayers will receive an extra $10 a week.

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That's not exactly a windfall, but a little something extra in your paycheck sure can't hurt, right? Well, actually, it could. Some taxpayers could end up with a smaller-than-average tax refund next year or — horrors — discover they owe the IRS money. You can avoid problems down the road by adjusting the withholding allowances on your W-4. Consider reviewing the number of allowances you claim if:

•You're a dual-income couple. The IRS withholding tables are designed to provide a maximum tax credit of about $400 for single taxpayers, and about $600 if you are married and file jointly, says Bob Trinz, senior tax analyst for Thomson Reuters. That could cause some working couples to receive a larger combined credit than allowed by law.

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For example, suppose you earn $75,000 a year, as does your spouse. Both of you claim two withholding allowances. You'll each get a $614 credit, for a combined credit of $1,228, according to Thomson Reuters. However, the maximum credit a married couple is eligible to claim is $800. Unless one or both of you increase the amount of taxes withheld from your paychecks, you could end up owing the IRS money when you file your taxes next year, Trinz says.

Conversely, Trinz says, if only one spouse works, the couple could end up with a smaller credit than they're entitled to. Here's an example, from Thomson Reuters: A married man earns $100,000 a year and claims four withholding allowances. His wife is a homemaker. He'll receive a credit of $614, even though the couple are entitled to an $800 credit. This couple can claim the balance of the credit when they file their taxes, or they can get the money sooner by reducing their withholding.

•You have more than one job. If you're working two jobs, both of your employers will adjust your take-home pay to reflect the new credit. The combined credit from both jobs could exceed the maximum $400 credit for individual taxpayers, says Michael O'Toole, director of government relations for the American Payroll Association.

•Your total income exceeds the thresholds for the credit. The Making Work Pay Credit phases out for single taxpayers with modified adjusted gross incomes of more than $75,000, and married couples with modified AGI of more than $150,000. Singles with modified AGI of more than $95,000 and couples with MAGI of more than $190,000 are ineligible for the credit.

Your employer will base the withholding calculation on the amount of income from your job. But if you have other sources of income — from a second job, for example — your total income could "bump you out of the range to be eligible for the full credit," says Amy McAnarney, director of H&R Block's Tax Institute.

Likewise, some dual-income couples could run into problems if one spouse receives the credit but the couple's combined income exceeds the income cutoff.

Reviewing your W-4

Even if you have no tax-credit worries, take a look at your W-4 anyway. Tax preparers recommend reviewing the number of allowances you claim on your W-4 whenever you have a major life change, such as the birth of a child, marriage or a home purchase. But a recent survey by H&R Block found that 44% of workers haven't adjusted their W-4s in at least three years.

If you had to write a big check to the IRS this year, that's a sign that you're not having enough withheld and need to reduce the number of allowances on your W-4. Likewise, taxpayers who receive a large refund should consider increasing the number of allowances they claim.

Many taxpayers resist this idea because they like receiving a check from the IRS. But in these economically challenging times, giving the government an interest-free loan makes no sense, says David Bergstein, a tax analyst for CCH CompleteTax, an online tax software program. When you file your taxes, he says, "You should break even."

There are several Internet calculators to figure out how many allowances you should claim. CCH offers one at completetax.com/calc.asp.

Sandra Block covers personal finance for USA TODAY. Her Your Money column appears Tuesdays. Click here for an index of Your Money columns. E-mail her at: sblock@usatoday.com.

READ MORE - Adjust withholding on W-4 to keep tax credit on track

Inflation-adjusted Savings Bonds hit 0% rate for first time

For the next six months, a new inflation-adjusted Savings Bond will provide exactly the same investment return as the space beneath your mattress.

Treasury announced last week that inflation-adjusted Savings Bonds purchased from May through October will earn 0% for the first six months they're held. This is the first time I Bond returns have fallen to zero since Treasury started issuing them in 1998, says Daniel Pederson, author of Savings Bonds: When to Hold, When to Fold, and Everything In-Between.

Consider this the downside of $2 gasoline. The I Bond consists of two components: a fixed rate that stays the same for the life of the bond and an inflation rate that's adjusted every six months. The inflation component for I Bonds issued from May through October is based on the change in the consumer price index from September through March.

Primarily because of sharp declines in the cost of energy, consumer prices fell at an annual rate of 5.56% from September 2008 through March 2009. The decline in the inflation rate will vaporize the 0.10% fixed rate for I Bonds issued from May through October. The drop will also wipe out the interest on older I Bonds with much higher fixed rates, says Tom Adams, author of Savings Bond Advisor. The 0% interest rate will affect "every I Bond that's ever been issued," he says.

The only good news is that I Bond owners won't lose any money. Under the Treasury formula, the earnings rate on I Bonds will never fall below zero. If you already own I Bonds, you won't earn any money during the relevant six-month period, but you won't lose any of your principal.

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This may come as small consolation to I Bond owners who are facing six months of oblivion. But before you ditch your I Bonds, there are a couple of factors to consider:

•When your inflation-adjusted rate will reset. The inflation component of your I Bond is adjusted every six months, depending on when you purchased your bond. If you own an I Bond that was purchased in April, for example, your rate won't drop to zero until October, Adams says. Until then, the bond will continue to earn an inflation-adjusted rate of 4.92%, plus the fixed rate that was in effect when you purchased your I Bond. Sell now, and you'll give up five months of above-average interest.

•The fixed rate for your I Bonds. If you purchased an I Bond in 1998 through 2001, you should hold on to it, even during this fallow period, Pederson says. Those bonds carry fixed rates of 3% or more for the life of the bond.

When high gas prices led to a surge in the inflation rate last spring, some of these older I Bonds earned more than 8%. Even if inflation rises to a modest rate of 2% to 3%, these bonds will earn 5% to 6%, Pederson says. But if you sell, you'll lose that fixed rate forever.

"Don't do something knee-jerk because you see a 0% rate," Pederson says. "Over the long haul, you could still have a very attractive investment."

On the other hand, if you own some I Bonds with lower fixed rates, the six-month 0% rate offers an opportunity to ditch them without paying a penalty. When you buy an I Bond, you can't redeem it for a year, and if you sell in less than five years, you'll forfeit the last three months of interest. But if your interest rate for those last three months is zero, cashing out early won't cost you anything.

While the recession has kept prices in check, many analysts believe large-scale government borrowing will eventually ignite inflation, which would increase the I Bond's return. But even if you agree that inflation is a looming threat, it's probably not a good idea to buy I Bonds now, Pederson says, because of the low fixed rate.

The 0.10% fixed rate Treasury is offering for I Bonds purchased in May through October means you'll earn only a hair above the inflation rate on any I Bond purchased from now through Oct. 31. If you believe I Bonds are a good long-term investment, Pederson says, "There's no risk to waiting until Nov. 1 and seeing if they do better with the fixed rate."

In addition to the I Bond, Treasury offers an EE Bond that pays a fixed rate for the life of the bond. Treasury said last week that EE Bonds issued from May through October will pay a rate of 0.7%, down from an already measly rate of 1.3% for EE Bonds issued from November through April. Even in this low-rate environment, Adams says, "It's just really hard to come up with an argument for investing in EE Bonds."

Sandra Block covers personal finance for USA TODAY. Her Your Money column appears Tuesdays. Click here for an index of Your Money columns. E-mail her at: sblock@usatoday.com. Follow on Twitter: www.twitter.com/sandyblock

READ MORE - Inflation-adjusted Savings Bonds hit 0% rate for first time

If you converted IRA to Roth in '08, you can still save on taxes

If you converted your individual retirement account to a Roth last year, you probably feel like someone who got married during a weekend in Vegas. It seemed like a good idea at the time, but now you're having serious second thoughts.

When you convert to a Roth, you're required to pay taxes on all pretax contributions and gains. The taxes are based on the value of your IRA at the time of the conversion. That makes an IRA conversion a smart move in a bear market — unless the market continues to plummet after you convert. When that happens, you could end up paying taxes on money you no longer possess.

For example, suppose you converted an IRA valued at $100,000 last spring. On April 15, you'll owe taxes on $100,000, even if your Roth is now worth less than half that amount.

Fortunately, reversing an ill-timed IRA conversion is a lot easier — and less expensive — than getting out of a madcap marriage.

You can undo the damage by "recharacterizing" your Roth. That process turns your Roth back into a traditional IRA, wiping out your tax bill.

If you don't think you can get the job done by Wednesday, you can buy yourself some time by filing for a six-month extension to file your 2008 tax return, says Barry Picker, an accountant and financial planner in Brooklyn, N.Y. After you recharacterize, you can file your tax return, and you won't owe taxes on the conversion, he says.

Just make sure you recharacterize by Oct. 15, which is the deadline for reversing IRAs converted in 2008. Otherwise, you'll be subject to steep penalties.

Back to the future

Recharacterizing doesn't mean you have to abandon your quest to convert your IRA to a Roth. If you recharacterize an IRA you converted last year, you can convert back to a Roth once 30 days have elapsed, says Ed Slott, an IRA expert and certified public accountant in Rockville Centre, N.Y.

Converting your IRA back to a Roth is a smart move, Slott says. Tax rates are likely to rise in the future, he says, so converting now will allow you to take advantage of current tax rates.

Once you convert to a Roth, withdrawals are tax-free, as long as you're at least 59½ and have owned the Roth for five years or more. "If the market comes back and values go way up, all of those gains will be tax-free forever," Slott says.

And converting now — or reconverting if you recharacterized your IRA last year — is a risk-free strategy, Slott adds. If the market continues to slide, you have until Oct. 15, 2010, to recharacterize your Roth.

Income limits lifted

Unfortunately, if your modified adjusted gross income exceeds $100,000, you can't convert a traditional IRA to a Roth.

That cutoff applies to both single taxpayers and married taxpayers who file jointly. Married couples who file separately are ineligible to convert.

But next year, the income restrictions on Roth conversions will disappear. Taxpayers who convert will also be allowed to postpone the tax bill. If you convert in 2010, you'll be allowed to pay half the tax bill in 2011 and the other half in 2012, Slott says.

Picker says he's advising his high-income clients to stash as much as possible in non-deductible IRAs this year so they'll have more money to convert in 2010.

Non-deductible IRAs are the only IRAs available for taxpayers who don't qualify for a Roth or a deductible IRA.

Many financial planners aren't big fans of non-deductible IRAs because withdrawals are taxed at ordinary income rates.

And if you own a non-deductible IRA, you're required to take minimum annual withdrawals once you turn 70½.

But once you convert your IRA to a Roth, those drawbacks disappear. Withdrawals are tax-free (as long as you meet the aforementioned requirements), and Roths aren't subject to the required minimum withdrawal rules.

You have until Wednesday to invest in a non-deductible IRA for 2008, Picker says.

You have until April 15, 2010, to invest in a 2009 IRA, but investing now will give your money more time to grow.

You'll still, of course, have to come up with the money to pay taxes on any gains you earn on your IRA. But allowing investors to postpone the tax bill — and then spread out the payments — will make that aspect of converting a lot less painful, Slott says, adding: "The government is giving everyone an interest-free loan to build a tax-free savings account."

Sandra Block covers personal finance for USA TODAY. Her Your Money column appears Tuesdays. Click here for an index of Your Money columns. E-mail her at: sblock@usatoday.com.

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comment:

I wonder why in the world financial advisors tell investors to open qualified accounts and then wait for a bear market (LOSE money) to convert to roth? Or I'm slow? Say you have $100K @25% tax is $25k so you get to convert $75K. Wait, now there is a bear market and you are down to $70K value @25% tax is $17.5K so you get to net 52.5K. - How in the world is that BETTER?

READ MORE - If you converted IRA to Roth in '08, you can still save on taxes

Adjust withholding on W-4 to keep tax credit on track

Your next paycheck will probably be a little fatter than usual, but it's not because your boss thinks you're swell. Instead, the increase reflects the Making Work Pay credit, part of the economic stimulus package enacted this year.

Most taxpayers will receive a credit of about $400, or $800 for married couples. Unlike last year, you won't receive a check in the mail. Instead, the credit will be spread out over the year. Most taxpayers will receive an extra $10 a week.

That's not exactly a windfall, but a little something extra in your paycheck sure can't hurt, right? Well, actually, it could. Some taxpayers could end up with a smaller-than-average tax refund next year or — horrors — discover they owe the IRS money. You can avoid problems down the road by adjusting the withholding allowances on your W-4. Consider reviewing the number of allowances you claim if:

•You're a dual-income couple. The IRS withholding tables are designed to provide a maximum tax credit of about $400 for single taxpayers, and about $600 if you are married and file jointly, says Bob Trinz, senior tax analyst for Thomson Reuters. That could cause some working couples to receive a larger combined credit than allowed by law.

For example, suppose you earn $75,000 a year, as does your spouse. Both of you claim two withholding allowances. You'll each get a $614 credit, for a combined credit of $1,228, according to Thomson Reuters. However, the maximum credit a married couple is eligible to claim is $800. Unless one or both of you increase the amount of taxes withheld from your paychecks, you could end up owing the IRS money when you file your taxes next year, Trinz says.

Conversely, Trinz says, if only one spouse works, the couple could end up with a smaller credit than they're entitled to. Here's an example, from Thomson Reuters: A married man earns $100,000 a year and claims four withholding allowances. His wife is a homemaker. He'll receive a credit of $614, even though the couple are entitled to an $800 credit. This couple can claim the balance of the credit when they file their taxes, or they can get the money sooner by reducing their withholding.

•You have more than one job. If you're working two jobs, both of your employers will adjust your take-home pay to reflect the new credit. The combined credit from both jobs could exceed the maximum $400 credit for individual taxpayers, says Michael O'Toole, director of government relations for the American Payroll Association.

•Your total income exceeds the thresholds for the credit. The Making Work Pay Credit phases out for single taxpayers with modified adjusted gross incomes of more than $75,000, and married couples with modified AGI of more than $150,000. Singles with modified AGI of more than $95,000 and couples with MAGI of more than $190,000 are ineligible for the credit.

Your employer will base the withholding calculation on the amount of income from your job. But if you have other sources of income — from a second job, for example — your total income could "bump you out of the range to be eligible for the full credit," says Amy McAnarney, director of H&R Block's Tax Institute.

Likewise, some dual-income couples could run into problems if one spouse receives the credit but the couple's combined income exceeds the income cutoff.

Reviewing your W-4

Even if you have no tax-credit worries, take a look at your W-4 anyway. Tax preparers recommend reviewing the number of allowances you claim on your W-4 whenever you have a major life change, such as the birth of a child, marriage or a home purchase. But a recent survey by H&R Block found that 44% of workers haven't adjusted their W-4s in at least three years.

If you had to write a big check to the IRS this year, that's a sign that you're not having enough withheld and need to reduce the number of allowances on your W-4. Likewise, taxpayers who receive a large refund should consider increasing the number of allowances they claim.

Many taxpayers resist this idea because they like receiving a check from the IRS. But in these economically challenging times, giving the government an interest-free loan makes no sense, says David Bergstein, a tax analyst for CCH CompleteTax, an online tax software program. When you file your taxes, he says, "You should break even."

There are several Internet calculators to figure out how many allowances you should claim. CCH offers one at completetax.com/calc.asp.

Sandra Block covers personal finance for USA TODAY. Her Your Money column appears Tuesdays. Click here for an index of Your Money columns. E-mail her at: sblock@usatoday.com.

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comment:

Letting the government have use of your hard earned money, interest free, for a whole year is STUPID. Through adjusting my own W4 and having a few dollars each pay additional withholding taken out - I and the government break even at tax time. It's great as far as I'm concerned.

READ MORE - Adjust withholding on W-4 to keep tax credit on track

Obama Gets Tough on Abuses by Credit Card Industry

President Obama pledged Thursday to support legislation that protects credit card borrowers from unfair rate increases and cracks down on issuers who engage in deceptive lending practices.

Obama said that while credit cards are an important source of liquidity for consumers and small businesses, "The days of any time, any reason rate hikes and late fee traps have to end."

His remarks were made after a White House meeting with 14 leading credit card executives to discuss the impact of issuers' practices on consumers and the economy.

As credit card issuers grapple with ballooning loan losses, they've raised rates and fees for millions of consumers. From March 2007 through February 2008 alone, about 70 million credit card accounts — nearly one in four accounts — had their rates raised, costing consumers at least $10 billion in additional finance charges, estimates Pew Charitable Trusts, a public policy group.

Obama said he wants to make sure that credit card companies "are able to make a reasonable profit — but they're doing so in a way that is responsible." Issuers who engage in illegal practices will "feel the full weight of the law," he warned.

The administration's efforts lend momentum to pending bills in Congress. Already, the Federal Reserve has issued a rule that would restrict issuers' ability to raise interest rates on existing debt. But the rule doesn't take effect until July 2010. The White House said it's looking for stronger protections than provided by the rule.

Also Thursday, Sen. Charles Schumer, D-N.Y., and Sen. Christopher Dodd, D-Conn., called on the Federal Reserve to impose an "emergency freeze" on issuers' ability to raise interest rates on existing debt. USA TODAY's research has found that for a growing number of consumers, credit card rate increases — rather than mortgage troubles — are pushing them into economic distress.

Ed Yingling, CEO of the American Bankers Association, says that issuers raise rates based on risk. If regulation "goes too far, it would undermine the availability of credit when we're in a credit crisis," he warns.

But Adam Levitin, law professor at Georgetown University, says that absent strong regulation, issuers will devise new ways to boost profits at consumers' expense. "I worry that all this leads to is a game of whack-a-mole, where Congress says, 'Don't do A, B and C,' and the card industry is popping up with another set of practices," says Levitin.

Levitin believes the regulatory system needs a "structural change." Instead of telling issuers what they can't do, regulators should tell them the only things they can do, he says.

By Kathy Chu, USA TODAY
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